Run Your Business As If It Is Going on the Sales Block

By Daniel B. Price

 Whether one is looking to sell, buy, or grow organically, the preparation and organization of an agency’s financial, book of business and corporate information as if a sale is imminent should start today.  This month we begin a series of articles that discuss what you can begin doing today to put your operation on course to maximize value and ease the transition when in fact it becomes time to explore exit opportunities.
 
In reality, a sale may not be in the near future. However, running the agency today as if it were going on the sales block will inevitably improve management practices and overall efficiency and effectiveness; thus translating into higher earnings and undoubtedly increasing long-term shareholder value. 
 
It has been our experience that when it comes to selling an insurance brokerage, some of the most successful agency owners start planning at least five and as far as 10 years before they actually plan on exiting the business. This allows ample time to explore various market opportunities, begin the internal transition process and to systematically segue out of the business. For those who like the thought of retiring at 55, age 45 is by no means too early to begin the process of thinking about their long-term exit strategy.
 
Get the Financial Books in Order
One of the first and most critical steps in getting an agency ready for an ownership transition is to get the financial books in order. In an actual internal or external transaction the amount and detail of information a particular acquirer will request varies but one thing is for sure: the quality of information a seller is able to provide goes directly to the overall quality of the agency itself and its management team.  
 
Historical financial statements are often times one of the best indicators of future performance of a business.  To these ends, buyers will put your financial information under a microscope.  Audited financial statements provide the highest level of assurance that the financial picture of an agency is in fact as it has been presented to be.  The greater reliability a buyer can place on the financial statements, the more likely it is that a seller will receive additional purchase consideration either through a higher overall price and/or   through a more favorable transaction structure (i.e. more upfront or an earn out with lower performance metric thresholds).  This is simply the old risk/reward trade off, by having quality financial statements you are helping reduce the buyer’s perceived level of risk and thus he is more likely to provide you with more return. 
 
It is a fact that historical financial statements of closely held businesses rarely reflect the true profitability of the business without certain adjustments.  Whether the adjustments would be to eliminate owner perks such as country club dues or personal automobiles, or to remove one-time expenses related to moving or sponsorship of a local charity event, it is of no matter.  The key to getting a buyer to sign-off on any suggested financial statement adjustment is the amount of tangible support and justification a seller can provide. 
 
Simply saying that 25% of this expense line item and 50% of that expense line item are “personal” and therefore these line items should be adjusted will not suffice.  If a buyer is expected to give “full credit” in the purchase price for discretionary items, extensive and detailed records are required.
 
Buyers will only recognize and pay for earnings that are easily discernable and clearly documented. On a related note, buyers become more skeptical with each “normalizing” adjustment required to arrive at the true economic run rate of a business.
 
Revenue adjustments are related but can also sometimes come under the guise of a slightly different animal. You may have the usual non-recurring revenue adjustments, such as a one-time gain from the sale of equipment, and these adjustments are understandable.  However, what is clearly unacceptable to most buyers is revenue that has not been recorded on the financial statements and tax returns.  An unrecorded revenue adjustment is clearly straddling the line between tax avoidance, which is perfectly acceptable, and tax evasion, which is obviously not acceptable.  This type of situation should be cleaned up long before contemplating a sale or do not expect a buyer to give you credit for this revenue. Effectively, Uncle Sam has already compensated you for this revenue through reduced taxes.  If a buyer gets wind of this type of situation the deal will likely be stopped in its tracks as this type of a situation goes right to the integrity of management and the underlying quality of the agency.
 
The removal of non-operating assets and liabilities from the balance sheet is another important aspect of cleaning up financial statements.  Their presence will just complicate and confuse matters if and when you decide to sell.  If an asset is not contributing to the earning power of the agency and it is not required for ongoing operations, than mechanisms for removing it from the balance sheet should be considered.  An example of this type of adjustment is automobiles owned by the agency (including the accompanying debt), that are in reality personal automobiles of the agency owners.  By cleaning up the balance sheet a more accurate picture of the true financial position of the agency is often revealed.  Most likely a buyer is going to uncover the true financial picture of the agency at some point during their due diligence review so you might as well approach them honestly right from the start.
 
Next month we’ll discuss the necessity for a first class agency management system and when implemented correctly, how this invaluable resource translates into a more effective / efficient operation and more likely than not higher transaction consideration.
 
 
Daniel B. Price is vice president at Hales & Company in Harrisburg, Pa. This is an abstract from National Underwriter Property –Casualty, April 27, 2009.
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